Comparison to Berkshire Hathaway Shows Sears Has Hope

The comparisons have been rampant about Warren Buffett's Berkshire Hathaway (BRK.A) and Eddie Lampert's Sears Holdings (SHLD). Let's look, and rather than comparing the 42 year old Berkshire with the 2 year old Sears in both their current states, let's look at Berkshire's beginnings and take an apples to apples approach when making the comparison.

First things first. This is not a "who is better" look between Buffett and Lampert but a look at the beginning of both businesses and the investment by both owners. Most people do not know about Berkshire's beginnings and if we are going to make the comparison, we need to look back at Warren early experiences so that we can look at Lampert's and draw honest conclusions. One cannot look at the finished product of Berkshire and then look at Sears Holdings, still in its infancy and draw any meaningful comparison. Doing that is a bit like one neighbor with a kid in kindergarten contrasting their child to the neighbor's child, a 27 year old doctor, and making an effort to discern their own child's future from that. Can't be done.

Given the recent stock slide of Sears Holdings from $190 to $130, many people have jumped ship on Lampert and given up on Sears and their Chairman. Gone now are the Buffett comparisons and the doubters have surfaced. However, if one looks at the history of Berkshire one also sees dramatic price drops. In 1973-74 the stock dropped from $90 to $40 a share. After the '87 stock crash it fell from $4,000 to $3,000. In 1990-91 it fell from $8,900 to $5,500 and from mid-1998 to 2000 the stock slid from $80,000 to $40,800. A drop in the share price of that magnitude has very little to do with the ability of either Buffett or Lampert to do what they do best. As a matter of fact at the turn of the century, Buffett was deluged with doubters who said he was "out of touch" and did not understand the "new paradigm" of business. I think we all know how that turned out.

If we look closer at the beginnings, Berkshire was bought by Warren is 1965 for about $16 a share and, according to Buffett, "had no net cash". In fact, according to Buffett, in the previous 10 years the business had earned "less than nothing". After two years of ownership (the same time period Lampert has owned Sears) shares fetched between $17 and $21 in 1967, virtually flat. Sears shares conversely have gone from $50 when the deal was announced to the $130 they sit at today. At the end of the 4th year Buffett owned Berkshire, it traded between $32 and $39 a share.

Earnings: In 1965 and 1966 Berkshire was profitable but in 1967 it saw a dramatic downturn in earnings and at that point Buffett used Berkshire cash and acquired National Indemnity Insurance in the spring of 1967. It was an attempt by Buffet to level out the cyclical earnings of the textile industry and he thought the insurance float would provide a buffer for the erratic textile operations. Soon after that was, See's Candy, Wesco, Illinois National Bank ans Sun Newspapers.

When Lampert acquired Sears it had lost almost $5 billion the previous 4 years and since he took over it has earned about $3.7 billion in just two and a half years. More importantly it produces nearly $2 billion a year in cash for Lampert to invest in the business. (That number will clearly be down this year due to the retail environment.)

Lampert doubters will point to this years profit decline as their proof that what he is doing at Sears is not working. However, if one looks at Berkshire in the last decade, one will see large declines in earnings in 1999, 2001 and 2004 due to a challenging insurance environment. With retailers like Target (TGT), Home Depot (HD), Lowes (LOW), Macy's (M) and JC Penney (JCP) all lowering expectations recently, 2007 has shaped up to be a similar environment for retailers.

An earnings decline is not proof that what he is not doing is not working, nor is the Berkshire declines in those years meant to absolve any issues at Sears, but it is meant to illustrate that not all earning go up in perpetuity and a bad year does not mean disaster. What Berkshire fans always point to is the cash available for Buffett to use for investment in years that earnings suffer. Lampert devotees point to the same metric and how it is being used. Sears is so young compared to Berkshire that Lampert followers currently are focused on his use of that cash within Sears (repurchases, debt reduction, IT investment) and how those actions will maximize its production later on.

Shares: Like Buffett in his early Berkshire years Lampert is using weakness to buy more shares. Buffett began buying Berkshire shares in 1962 and took control in 1965. He kept buying in 1965 until he had 70% of Berkshire shares and did not become chairman until 1970. Lampert first bought Sears in 2004 and 2005 and has kept buying. Estimates are that he controls almost 60% of Sears shares after the current buyback is done. Sound familiar?

The business: Buffett was very judicious in his use of Berkshire's cash in the early years just as Lampert has been with Sears. Unlike Berkshire, Sears is in a business that will continue to earn Lampert money and produce large amounts of cash and will not eventually be forced to close like Berkshire was in 1985 (the textile mill). That being said, Lampert also unlike Buffett is sitting on a fortune in real estate in Sears Holdings and also billions of dollars in licensing fees from the valuable Craftsman and Kenmore lines should he opt to monetize them. Just because he has not, doesn't mean he won't, that is where the "value" lies.

Track Record: Both Buffett and Lampert ran private investment operations before the big acquisition. Both had track records that trounced the markets as a whole and made themselves and investor very wealthy. Both were long term value investors who kept their thoughts close to the vest and invested with a time frame unlike their peers. Both experienced difficulties in the early years of their ownership of the business and used that difficulty to increase their ownership in that business.

In short, Sears is a better "business" than Berkshire was in 1965, what remains to be seen is what Lampert's next move will be with that business. I do not think anyone has ever gotten very rich betting against either Buffett or Lampert.

Why start trying now?

Disclosure: Author long in SHLD.

Comments

[FIG trader]

I don't get it. What do two personalities and two "stock performances" have to do with two companies that are as different as night and day? BRKA is a portfolio of companies and investable "float" form insurance. SHLD is a retailer, with some RealEstate assets? Tell me I missed something.

[todd su]

fig,

it is a look at the early years. berkshire was a textile mill, not an insurance company when it started. people tend to forget that when they make the lampert / buffett comparison. the exercise was to see what it was when it started to see what it morphed to. to think sears and kmart are all that sears holdings will be 10 years from now causes people analyze it wrong.

it was simply an effort to compare both companies at their early stages

[youngredwood]

can you extend the comparison a bit further. when buffet bought Berkshire, did he turn his full attentions to it--i.e., fold in his other investment activities? What about Lampert? Is he running SHLD and a hedge fund, and if so where, dollarwise, is he most committed?

[todd su]

he folded the buffett partnership when he bought berkshire and people were offered money or shares in hathaway...

Lampert.... too early tell. it is a bit like a hedge fund with the credit swaps he has but for now it is a retailer. he has spent most of his energies repairing the huge mess he bought and financially, the company is in great shape and the balance sheet is clean. my guess is in 3-4 years it will be a much different operation though..... at least more diverse

[Al Rob]

Acutually, I've made money shorting SHLD this year. And I have made money betting against AZO in the past. Todd, have you ever looked at the history of ESL's investment in AZO or AN? He hasn't exactly created a new berkshire with those. SHLD isn't the first retail company ESL has bought and I would argue that AZO was a more attractive franchise than SHLD. SHLD is not the next berkshire.

[todd su]

al,

i said betting against them "long term". either company could have been shorted and people could have made tons at times in the past..

he does not control AZO or AN..

[FIG trader]

You still miss the point, and misunderstand Buffett and methods available to him; While I have no opinion on Ed Lampert or SHLD, BRKA, and its earlier years had insurance operations (besides just stock holdings in GEICO; 50% pre acquisition) with available float for investing. Its the earlier stock performance that gave him capital available to continue investing; Free cash from any operations, as good as it may be can't drive the kind of performance that GEICO, especially in mature business. Likewise; SHLD, if it is growing fast, it would more than likely be reinvesting Capex in expansion; Where is capital available for building huge private equity portfolio; Sorry, you have to go back and learn the basics of Buffettology

[todd su]

fig,

incorrect. Warren began buying geico big in 1976-to 1981 investing $45.7 million in it. as late ad 1992 he only has 48% and bought the rest in 1995. he first bought in in 1971, 6 years after he took control of berkshire.

Berkshire's 1st insurance operation was not bought until year 3 (national indemnity). that was the point of the post. most people think Berkshire has
been into insurance from day one when the reality is far different.

i agree on your point on insurance vs retail and the point of the post was that retail (sears) is a better business that a textile mill which is all berkshire was until year 3.

it was a comparison of years 1 and 2 of the two businesses, do not jump ahead in Berkshire to year six and draw conclusions because we cannot compare when we do not know what sears will be in 4 years from now.

i am fully versed in buffetology, you are missing the point of the post

[Rohan]

It's not like Todd is going out on a limb here, guys. I think it's a fair analysis. No two situations are going to be exactly alike and maybe it requires a bit of creativity, but there are plenty of similiarities.

Al Rob says definitively that Sears is not the next Berkshire. Marty Whitman has expressed the opposite opinion in the past (hopefully that HTML link came through, it's the 2004 Business Week article on Lampert that you can Google): "There is no question [Lampert] will turn Kmart into an investment vehicle like Warren Buffett's...that's what I am valuing into the stock." Marty made a boatload of money and got out, which he explained in the 2005 3Q letter as follows: "At the prices Sears Common is now selling, the company has to succeed in a big way in order to justify these prices." So it was a valuation call.

Al, regarding the fact that you've made money shorting SHLD, if you actually read Todd's article you'll see he notes quite clearly that even BRK has declined significantly over certain stretches. So what? You want a cookie?

Regarding AZO and AN not becoming mini-Berkshires, I don't think I've ever heard anyone suggest that was his goal with either of those.

As for FIG trader, you aren't particularly imaginative, either. Saying Todd's missing the point of Buffettology is idiotic. Once again Todd clearly pointed out BRK's purchase of Nat'l Indemnity in the spring of '67 in order to get access to the float.

Perhaps your opinion is that Lampert simply cannot accomplish anything resembling a float within Sears (buying an insurer himself with the cash once he's revitalized SHLD a bit?), and sure, that's debatable. But the argument isn't remotely a checkmate in your favor. There remain avenues for Lampert to generate cash through SHLD, so it's not like this story is over, which you guys seem to think.

[todd su]

rohan,

LOL.. your reply was better than mine

[Rohan]

It's not like Todd is going out on a limb here, guys. I think it's a fair analysis. No two situations are going to be exactly alike and maybe it requires a bit of creativity, but there are plenty of similiarities.

Al Rob says definitively that Sears is not the next Berkshire. Marty Whitman has expressed the opposite opinion in the past (hopefully that HTML link came through, it's the 2004 Business Week article on Lampert that you can Google): "There is no question [Lampert] will turn Kmart into an investment vehicle like Warren Buffett's...that's what I am valuing into the stock." Marty made a boatload of money and got out, which he explained in the 2005 3Q letter as follows: "At the prices Sears Common is now selling, the company has to succeed in a big way in order to justify these prices." So it was a valuation call.

Al, regarding the fact that you've made money shorting SHLD, if you actually read Todd's article you'll see he notes quite clearly that even BRK has declined significantly over certain stretches. So what? You want a cookie?

Regarding AZO and AN not becoming mini-Berkshires, I don't think I've ever heard anyone suggest that was his goal with either of those.

As for FIG trader, you aren't particularly imaginative, either. Saying Todd's missing the point of Buffettology is idiotic. Once again Todd clearly pointed out BRK's purchase of Nat'l Indemnity in the spring of '67 in order to get access to the float.

Perhaps your opinion is that Lampert simply cannot accomplish anything resembling a float within Sears (buying an insurer himself with the cash once he's revitalized SHLD a bit?), and sure, that's debatable. But the argument isn't remotely a checkmate in your favor. There remain avenues for Lampert to generate cash through SHLD, so it's not like this story is over, which you guys seem to think.

[FIG trader]

If by imagination you mean that anyone with decent track record in early years can be compared with Buffett, than by golly, add any of 1000 PM's or private equity managers to your analysis. Good luck. I guess you can claim credit for having imagination, and waste your time. I will be happy to not be part of that club of imaginative types. The presumption is that Lampert (or any of 1000 others) has either the ability or inclination to buy insurance assets, and run the business properly. For those in the know, there are companies that could potentially be in that circle of champions. LUK, MKL, FFH in ten or twenty years; some insurers, some not. The non-insurers have no float to invest but great investment track records; the insurers have great track records, but few non financial assets. MKL in particular is viewed as a potential peer, and has some 20 years track record, with no non financial assets to support investment (BV) growth. Tom Gaynor, the manager, has done remarkable thing from small base. How is SHLD, anything comparable again????

[todd su]

FIG,

i think you really aren't getting it. forget insurance. it has no relevance whatsoever in the early years of berkshire which was the point if the post....

the way warren ran berkshire then and lampert is running shld now are similar.